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mortgage application rates Jerry Jones CPAReasons For Falling Mortgage Rates

This year's falling mortgage rates have been a surprise to Wall Street and economists, in general. Mortgage rates were expected to climb toward five percent or higher this year because the Federal Reserve was ending its third round of quantitative easing (QE3).

The opposite has happened instead.

As the Federal Reserve has reduced its involvement in the mortgage-backed securities (MBS) market by $35 billion monthly over the last nine months, and made plans to terminate QE3 with a final $5 billion QE3 reduction later this month, mortgage rates have dropped.

This week's average conventional 30-year fixed rate mortgage rate expected to show a half-point drop as compared to January 1; and, with 15-year rates expected to show a similar range of improvement.

So how did so many "experts" get it wrong on this? The answer is the same as always: It's not the events we expect which cause mortgage rates to move -- it's the events we don't.

As fast as the Federal Reserve is pulling out of MBS, global investors are pouring in. A few reasons why include the following.

Weakening Global Economies

At the start of the year, there were signs of weakness in China's economy and the economy of the Eurozone. As the year has progressed, however, those signs of weakness have amplified.

Dragged down by its housing market, the broader Chinese economy has underperformed while the Eurozone economy may be headed toward recession.

Neither outcome was expected 10 months ago and pessimism is growing among economists and consumers. This shift in sentiment has prompted investors to seek "safe" investments during this period of uncertainty -- an asset class which include U.S. mortgage-backed securities.

It's a well-known trading pattern known as flight-to-quality and, so long as global economies remain weak, mortgage rates will benefit.

Conflict, War, and The Ebola Virus

It's not just "weak economies" which can stoke a flight-to-quality -- strife and disease can do the same and, since the start of January, there's been a bevy of headlines which have helped to drag U.S. mortgage rates down.

In addition to the political events surrounding Russia and Ukraine, there has been ongoing armed conflict between Palestine and Israel; and in Syria and Iraq.

Furthermore, recently, there has been growing concern about the Ebola virus and its potential to disrupt world economies.

War and sickness create uncertainty which can push investors toward safer asset classes. Mortgage rates have been lower, in part, because of the flight-to-quality these events have sparked.

Low Inflation Rates

A third reason why mortgage rates have dropped through 2014 is that inflation rates have not increased as expected.

Inflation is the enemy of low mortgage rates. It follows, then, that the absence of inflation is good for low mortgage rates.

"Inflation" is the rate at which the U.S. dollar loses its purchasing power. When inflation rates rise, the dollar buys fewer goods and services and, when inflation rates drop, the dollar can buy more goods and services.

Because mortgage backed securities are priced in U.S. dollars, inflation's link to mortgage rates is fairly straight-forward.

When inflation rates rise, the value of owning a mortgage-backed bond drops because bond payments have less value to the holder. In response, bond holders sell their MBS which increases the market supply and leads bond prices lower.

When bond prices drop, mortgage rates rise.

Conversely, when inflation rates drop, the value of a mortgage bond grows and that's exactly what we've seen through the first three quarters of this year.

Inflation rates remain firmly below the Federal Reserve's 2% target rate despite a near-zero percent Fed Funds Rate, an improving U.S. economy, and the huge stimulus provided by QE3.

With inflation rates low, mortgage rates drop.

Ron Moschetti – Mortgage Loan Professional

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